While environmental groups and other stakeholders have been working hard to delay – if not derail- major pipeline projects like Keystone, oil companies have been working hard to find alternative ways to get their crude oil to market:

blog1A single unit train can move up to 90,000 barrels of oil.  Photo source

Rail transportation is viewed by some as a stop-gap measure because it is more costly per gallon-mile as compared to pipeline transport. But it is has some clear advantages. Trains can directly access virtually any market in North America.  Producers can more quickly shift where the oil is shipped.  In general, expanding rail transport capacity requires less regulatory oversight.

The graph below documents the striking increase in the number of oil-filled tank cars in recent years. To put these numbers in perspective, the percent of domestic crude oil production carried by rail has risen from approximately 1 percent in 2010 to 10 percent in 2013. In California, the Energy Commission is projecting that rail deliveries of crude oil could account for 25 percent of the state’s total by 2016.

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Source: Association of American Railroads

As the number of oil-filled tank cars increases, so has the number of train accidents. Last year more oil spilled from trains in the United States than in the previous four decades. A series of tragic, high profile derailments has focused attention on the damages that can result when crude oil is translated by rail. The debate over what – if anything – the government should do to reduce the risks of further damage is both old and new.

Railways and the problem of social cost

Almost a century ago, trains throwing sparks into neighboring fields and forests helped ignite a canonical debate in economics. These railroad sparks sometimes set fire to farms and woodlands.  Writing in 1920, Alfred Pigou observed that if the railroads fail to account for these damages, profit maximizing operating decisions would not be socially optimal. He proposed taxation as a means of aligning private and social interests.

In 1960, Ronald Coase revisited this example in a famous paper titled The Problem of Social Cost. He observed that if property rights are well defined and costless to enforce, private bargaining between railroads and landowners should result in a socially efficient outcome. (Interested readers should see Severin’s post celebrating Coase’s influential insights).

Current debates about transporting oil by rail bring us back to the question of how to internalize this canonical social cost. There are at least two reasons why modern-day costs of transporting crude oil might not be fully internalized by the firms making key operating decisions.

More than sparks

When Pigou and Coase were pondering  “railway nuisances”, they had in mind relatively small sparks thrown off railroad tracks. Damages caused by these sparks were presumably less devastating than that which can result when a unit train carrying  crude oil runs off the rails.

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Tragic derailment in Lac Megantic, Quebec (Paul Chiasson / THE CANADIAN PRESS)

Today’s railroads are liable for the crude they carry.  But a recent Wall Street Journal article reports that current insurance coverage does not begin to cover the damages associated with a worst-case scenario

Take, for example, the tragic derailment in Lac-Mégantic, Quebec. It is estimated that the clean up costs alone will exceed $200 million. The train’s operator had liability insurance of $25 million. The railway has sought bankruptcy protection. The government has had to step in to cover the remaining expenses.

So long as taxpayers serve as the backstop, some fraction of the damages will remain external to railway operating decisions. This can result in under-investment in risk mitigation. (This “judgement proof” problem is not unique to the railroad industry. See, for example, Lucas’s recent paper which discusses how existing bond requirements provide inadequate incentive to protect against accidents in the natural gas industry).

A principle-agent problem?

Railway operators own the locomotives, employ crews, and provide infrastructure (tracks, signals, etc).  But there has been a relatively recent shift in rail car ownership. Over 50 percent of the tons shipped on the North American railroads are now moved in cars owned by non-railroad leasing companies. These railcar lessors make important decisions about the safety attributes of the tank cars that ride the rails.

Common-carrier obligations prevent railroads from refusing hazardous cargo. This could give rise to a principal-agent problem when a railway is liable for damages caused by accidents involving rail cars that they do not own or maintain. Moreover, industry analysts have argued that railroads are limited in their ability to pass along product-specific insurance costs in their rates.  If rail prices cannot fully signal the insurance costs of carrying risky cargo, carriers may under-invest in risk mitigation measures.

Last month, the nation’s largest hauler of crude oil (BNSF Railway Company) made headlines when it announced that it would purchase its own fleet of 5,000 oil tank cars with safety features that exceed the latest industry standards. This was hailed as important voluntary commitment to the improvement of safety standards for the transportation of crude by rail.  However, this case is unique in that the parent company stands to benefit from the railroad’s voluntary investment in safer cars. BNSF is owned by Warren Buffet’s Berkshire Hathaway which also happens to own one of the largest U.S. railcar makers. Other railroad companies with less to privately gain from such a commitment seem unlikely to follow suit.

An old problem in need of a new solution

The punchline here is that current levels of investment in railway and rail car safety are almost certainly too low.  Ideally, the government would intervene with policies designed to incentivize efficient investments in risk mitigation. But to implement these policies cost-effectively, we need to know how and where rail accidents are most likely to happen, and how costly these accidents are likely to be.

The Congressional Research Service recently noted that data tracking oil spills from rail transport do not currently exist. This seems like an important – and highly policy relevant – area for future research. Given current – and projected – volumes of oil moved by rail, a better understanding of how damages from rail transport of hazardous materials manifest could play a critical role in informing new policy solutions.